Chapter 7: Distribution Strategies CMB 8050 Matthew J. Liberatore

1. Chapter 7: Distribution Strategies CMB 8050 Matthew J. Liberatore

2. 7.1 Introduction • Focus on the distribution function. • Various possible distribution strategies, and the opportunities and challenges associated with these strategies. • Two fundamental distribution strategies: • Items can be directly shipped from the supplier or manufacturer to the retail stores or end customer • Use intermediate inventory storage points (typically warehouses and/or distribution centers). • Issues with warehouses • Manufacturing strategy (make-to-stock vs. make-to-order) • Number of warehouses • Inventory policy • Inventory turn over ratio • Internal warehouses vs. outside distributor • Owned by a single firm or by a variety of firms

3. 7.2 Direct Shipment Distribution Strategies • Advantages: • The retailer avoids the expenses of operating a distribution center • Lead times are reduced. • Disadvantages: • Risk-pooling effects are negated • Manufacturer and distributor transportation costs increase • Commonly used scenarios: • Retail store requires fully loaded trucks • Often mandated by powerful retailers • Lead time is critical. • Manufacturer may be reluctant but may have no choice • Prevalent in the grocery industry • lead times are critical because of perishable goods.

4. 7.3. Intermediate Inventory Storage Point Strategies • Variety of characteristics distinguish different strategies. • Length of time inventory is stored at warehouses and distribution centers. • Strategies: • Traditional warehousing strategy • distribution centers and warehouses hold stock inventory • provide their downstream customers with inventory as needed. • Cross-docking strategy • warehouses and distribution centers serve as transfer points for inventory • no inventory is held at these transfer points. • Centralized pooling and transshipment strategies • may be useful when there is a large variety of different products

5. Traditional Warehousing • Inventory management and risk pooling key factors • Other factors also play a significant role • Centralized vs Decentralized Management • Central vs Local Facilities

6. Centralized vs Decentralized Management • Decentralized system • Each facility identifies its most effective strategy without considering the impact on the other facilities in the supply chain. • Leads to local optimization. • Centralized system • decisions are made at a central location for the entire supply network. • Typical objective: minimize the total cost of the system subject to satisfying some service-level requirements. • Centralized control leads to global optimization. • At least as effective as the decentralized system. • Allow use of coordinated strategies • If system cannot be centralized • often helpful to form partnerships to approach the advantages of a centralized system.

7. Central vs. Local Facilities • Centralized facilities • Employ both fewer warehouses and distribution centers • Facilities are located further from customers. • Other factors: • Safety stock. Lower safety stock levels with centralized facilities • Overhead. Lower total overhead cost with centralized facilities • Economies of scale. Greater economies of scale with centralized facilities • Lead time. Lead time to market reduced with local facilities • Service. • Utilization of risk pooling better with centralized • Shipping times better with local • Transportation costs. • Costs between production facilities and warehouses higher with local • Costs from warehouses to retailers lesser with local

8. A Hybrid Decision • Some products use centralized strategy while others use local strategy • Not an either or decision • Varying degrees of centralization and localization due to the varying levels of advantages and disadvantages

9. Cross-Docking • Popularized by Wal-Mart • Warehouses function as inventory coordination points rather than as inventory storage points. • Goods arriving at warehouses from the manufacturer: • are transferred to vehicles serving the retailers • are delivered to the retailers as rapidly as possible. • Goods spend very little time in storage at the warehouse • Often less than 12 hours • Limits inventory costs and decreases lead times

10. Issues with Cross-Docking • Require a significant start-up investment and are very difficult to manage • Supply chain partners must be linked with advanced information systems for coordination • A fast and responsive transportation system is necessary • Forecasts are critical, necessitating the sharing of information. • Effective only for large distribution systems • Sufficient volume every day to allow shipments of fully loaded trucks from the suppliers to the warehouses. • Sufficient demand at retail outlets to receive full truckload quantities

11. Inventory Pooling – GM Example • 1,500 Cadillacs parked at a regional distribution center in Orlando • Await delivery to dealers statewide within 24 hours • 10% to 11% sales loss because a car is not available… • Test program expected to: • improve customer service • boost sales of Cadillacs by 10%

12. Centralized Pooled Systems Perform Better • For the same inventory level, a centralized system provides: • higher service level • higher sales • Push-pull supply chain • Moving from a push supply chain • Dealers have to order before demand is realized • To a push-pull supply chain • Dealers pull from regional distribution centers. • Implications: • End consumers will see better customer service • More cars are available to them.

13. Other Factors • Will GM sell more cars to GM dealers? • Total number of cars ordered by dealers will not necessarily increase, even as customer service increases. • What about the dealers? • Dealers have access to more inventory • Potentially can sell more. • Levels out the playing field between dealers. • Small dealers would favor such a system Competitive advantage of large dealers wiped out

14. Example of Inventory Pooling • Two retailers face random demand for a single product. • No differences between the retailers • Compare two systems • centralized pooled system, • retailers together operate a joint inventory facility • take items out of the pooled inventory to meet demand. • decentralized system • each retailer individually orders from the manufacturer to meet demand • In both systems, inventory is owned by the retailers

15. The Two Systems FIGURE 7-10: Probabilistic demand faced by each retailer FIGURE 7-9: The centralized and decentralized systems

16. Other Data • Wholesale price = $80 per unit • Selling price = $125 per unit • Salvage value = $20 per unit • Production cost = $35 per unit

17. Costs and Profits in the Two Systems • Decentralized system • Each dealer orders 12,000 units • Expected profit per dealer = $470,000, Total = $940,000 • Expected sales = 11,340 units, Total = 22,680 units • Manufacturer profit = $1,080,000 • Centralized system • Two dealers together will order 26,000 units • Total expected profit = $1,009,392 • Joint expected sales = 24,470 units • Manufacturer profit = $1,170,000

18. Customer Search • If the customer arrives at a dealer and does not find the item • Switches to another dealer • Helps the manufacturer sell more products • Which system is better under customer search? • No impact on the centralized system

19. Impact on Decentralized System • If a dealer knows that its competitors do not keep enough inventory • this dealer should raise the inventory level to satisfy: • its own demand • demand of customers who initially approach other dealers with limited inventory. • If a dealer knows that its competitors has significant inventory • this dealer will reduce the inventory level • It is not likely to see customers who switch • Dealer’s strategy depends on its competitor’s strategy. • Dealers may/may not know their competitor strategy • not clear how they decide on their inventory level. • not clear about the impact of search on the manufacturer

20. Nash Equilibrium (Game Theory) • If two competitors are making decisions, they have reached Nash equilibrium if they have both made a decision • Both have decided on an amount to order • neither can improve their expected profit by changing the order amount if the other dealer doesn’t change his order amount.

21. Example • α = percentage of customers that search the system • Each retailer can determine what their effective demand will be if the other retailer orders a specific amount. • Based on this information, they can calculate how much they should order given any order by their competitors. • Best response

22. Best Response with α=90% FIGURE 7-11: Retailers’ best response

23. Nash Equilibrium of the System • Retailer one orders about 20,000 units, retailer two will respond by ordering about 12,000 units • If this is the case, then retailer one should modify its strategy and reduce the order quantity • No retailer has an incentive to modify its strategy • They order amounts associated with the intersection of the two curves. • Optimal order quantity for each retailer = 13,900 units • Total expected profit for each retailer = $489,460 • Total expected profit = $978,920 • Total expected sales = 25,208 • Total amount ordered from the manufacturer = 27,800 • Manufacturer’s profit = $1,251,000.

24. Decentralized and Centralized Systems for Search Level of 90% • Centralized system does not dominate the decentralized system. • Retailers prefer the centralized system • Manufacturer’s profit is higher in the decentralized system

25. As α Increases • Each retailer’s order quantity and profit increases • Retailers’ total expected profit will be higher in the centralized pooling system than in the decentralized system.

26. As α Increases • With larger α • retailers will order more in a decentralized system • manufacturer will prefer a decentralized system • retailers will prefer a centralized system • With smaller α • manufacturer will order less in a decentralized system • both the retailers and the manufacturer will prefer a centralized pooling system.

27. Effect of α on Amounts Ordered FIGURE 7-12: Amount ordered by dealers as a function of the search level

28. Critical Search Level • Presence of a critical search level • manufacturer prefers the centralized system below the level • otherwise, manufacturer prefers the decentralized system. • Manufacturer always prefers a higher search level

29. How Can the Search Level Be Increased? • Increase brand loyalty • customers will more likely search for a particular brand at another retailer if their first choice does not have the product in inventory. • Information technology initiatives to increase communication between retailers • increases the ease with which customers can search in the system • higher likelihood that customers will search in the system

30. Transshipment • Shipment of items between different facilities at the same level in the supply chain to meet some immediate need • Occurs mostly at the retail level • Can be achieved: • with advanced information systems • Shipping costs are reasonable • Retailers have same owner

31. Retailers with Different Owners • May not want to do transshipments • Distributor Integration strategies may be adopted • Not clear regarding inventory levels • A retailer’s strategy depends on competitors’ strategies

32. Which Strategy to Adopt? • Different approaches for different products • Factors: • Customer demand and location • Service level • Costs => transportation & inventory costs • Demand Variability

33. Summary of the Distribution Strategies

34. Summary • Critical to implement effective distribution strategies regardless of the total level of supply chain integration. • Strategies: • direct shipping • warehouses or distribution centers • Related decisions • Should there be many or only a few warehouses or DC’s? • Should inventory be held at these locations, or transshipped? • As a retailer, does it make sense to participate in a centralized inventory pooling system? • What about a transshipment system?